New Year, Same Themes

By TRG Advisors on January 9, 2023

Nonfarm Payrolls

The jobs market continues to be a bright spot for the economy. The December ADP Employment Report highlighted wages rising +7% y/y for job stayers, and +15% y/y for job switchers. The nonfarm payroll report also beat expectations, adding 223,000 jobs in December. Within the ISM surveys, employment sentiment was also strong, and the unemployment rate is back down to its record-low 3.5%.

Despite the strong wage growth, we are seeing a trend that it is softening. ADP noted that December saw the lowest pay growth since March 2022. The Fed is paying close attention to wage figures and while wage growth has been hot for a while, indication that the Fed might be getting the pace under control is positive.

Industries that continue to hire large quantities of new employees include leisure and hospitality, education and health services, and construction. Manufacturing activity is notably slowing – underscored by lower employment across every category of nondurable goods manufacturing, aside from food manufacturing. ISM leading indicators showed manufacturing PMI contracting for the second consecutive month in December with less new orders, higher inventories, and lower prices.

The nominal wage growth was +4.1% annualized for the final three-months of 2022, substantially lower than the 6.1% average at the end of 2021 – yet still above-trend historically.

Chart 1: The Pace of Nominal Growth Has Slowed from the Beginning of 2022¹

Positive Buffers vs. Low Expectations

In addition to a slower pace of wage increases, companies are also benefitting from lower input costs and more favorable foreign exchange (FX) pricing. Falling input costs result from less supply
challenges, lower fuel surcharges and more efficient labor. The U.S. dollar has fallen from its October peak by 9%, which should also benefit companies through the latter part of Q4 and onward.

Markets will be paying close attention to company guidance, and we anticipate most management to remain conservative. Earnings revisions have already reflected low expectations. Analysts are projecting -3.2% EPS growth for the S&P 500 in Q4, down significantly from the expected +4.6% at the end of Q3. Energy earnings will likely be the highlight, and we expect positive earnings revisions post their reports. Energy EPS is projected to expand +63% y/y in Q4.

According to the Conference Board Measure of CEO Confidence, 98% of CEOs indicated they’re preparing for a U.S. recession over the next 12-18 months. The survey indicated CEO confidence at its lowest level since the Great Recession. This suggests a shockingly high anticipation for recession. Whether or not a recession ensues at some point in the next 12-18 months, it’s often not a good idea to be on the same side of the boat as the 98% consensus.

Markets may already be pricing in this consensus thought. The S&P 500 is down -16% in the past 12-months. Within the S&P 500, 92 names are down more than 30% in the past 12-months. 77% of names in the S&P 500 are trading at a discount from 12 months ago (using forward P/E).

Financials to Kickoff Earnings

Financials report this week and expectations are low. The bright spot will be positive net interest income and net interest margins. We also expect to see higher reserve builds owing to the slowing macro environment and weak investment banking fees partially offset by strong trading results. Analysts project book value of the financial sector to contract by roughly -4% in Q4. Goldman Sachs (GS) announced it’s ready to lay off 3,200 jobs this week. We wouldn’t be surprised to hear more layoffs as the companies right size given the slowing economy.

Elevated Yields, Steep Inversion, Stable Credit Spreads

Yields remained steady up until Friday’s mixed, albeit betterthan-expected, economic data on Friday driving a rally in 2- and 10-year bonds, while the 3-month bill was unchanged. The 3-month/10-year spread that many economists use to gauge a recession closed Friday at -107 bps and is now 30 bps past its historic trough; despite the historic 3-month/10-year readings, High Yield credit spreads remain well off their highs and have been below +500 bps since early November. Municipal yields continue to lag Treasuries, and yields fell 15-18 bps across the curve, with the largest moves seen on the short end.